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United Natural Foods Struggles to Digest Its SUPERVALU Acquisition

Food wholesale giant United Natural Foods(NASDAQ: UNFI) has encountered a kink in its acquisition of competitor SUPERVALU: The wholesale and retail food distributor is performing below expectations just months after United Natural Foods (UNFI) purchased it for approximately $2.9 billion last October. UNFI's fiscal second-quarter 2019 earnings, reported on Wednesday, also revealed a goodwill impairment charge related to the transaction that hurt net income and earnings per share. Note that in the discussion that follows, all comparable numbers refer to the prior-year quarter, the fiscal second quarter of 2018.

What happened with United Natural Foods this quarter?

UNFI recorded a $370.9 million noncash impairment charge to SUPERVALU's goodwill, due to a change in UNFI's trading price post-acquisition. This item pushed net income and earnings per share into the red for the quarter, as seen in the table above.

The company also recorded a goodwill impairment of $11.2 million related to its Earth Origins Market retail business, which it divested in the fourth quarter of 2018.

Excluding an $8.5 million inventory fair-value adjustment booked in connection with the SUPERVALU acquisition, UNFI's gross margin slipped roughly 220 basis points to 12.53%, which the company attributed to the addition of the lower-margin SUPERVALU business and a shift in customer mix.

After removing the impairment charges, inventory adjustment, and $47.1 million of acquisition, integration, and restructuring charges, the company generated operating income of $18.5 million during the quarter.

Adjusted EBITDA of $142.6 million greatly outpaced the $79.8 million of adjusted EBITDA generated in the prior-year quarter, due to the addition of SUPERVALU earnings.

Nonetheless, adjusted EBITDA fell below management's expectations, as SUPERVALU earnings, while boosting the consolidated total, fell short. Management explained that SUPERVALU is experiencing some issues in the realignment and integration of its distribution centers with UNFI's distribution system.

Despite the higher costs related to SUPERVALU's distribution centers, UNFI reported progress on integrating the two organizations' supply chains. The company reaffirmed its expectation that it will realize $185 million in annual cost synergies in the fourth year following the merger.

UNFI made cash tax payments of $59 million during February in conjunction with a tax election that will allow it to utilize some of SUPERVALU's $2.9 billion in capital loss carryforwards. Management believes that utilization of the carryforwards will allow UNFI to realize roughly $300 million in tax savings over the next 15 years.

While Q2 was a disappointment that will have a carryover effect on how we're thinking about the balance of the year, the challenges that we're facing are short term in nature. We can fix them. I'm encouraged by the many positive improvements we're seeing in this business and the opportunity that's ahead of us to create the largest and most sophisticated supply chain and services network for retail grocery throughout the U.S. and Canada. Our teams are highly focused, and we are coming together quickly, [to] capture our synergies and execute our strategic vision.

Looking forward

UNFI adjusted its earnings outlook heading into the second half of its fiscal year. The wholesaler still expects revenue of $21.5 billion to $22 billion for fiscal 2019. Adjusted EBITDA, however, is now anticipated to settle between $580 million and $610 million, versus a previous range of $650 million to $665 million, due largely to SUPERVALU's early stumbles. Thus, it may take a few additional quarters for shareholders to realize the promised value of this merger of grocery distribution specialists.